L. Randall Wray

Recent Posts by L. Randall Wray

Representative Paul Ryan (R-WI), head of the House Budget Committee, says that reducing the federal government's deficit is a "moral challenge".

The majority of Americans want a government that serves the people.

Representative Paul Ryan (R-WI), head of the House Budget Committee, says that reducing the federal government's deficit is a "moral challenge".

He's right. Finally, one politician who recognizes that the hysteria about federal budget deficits and debt has nothing to do with economics. There is no credible economic theory and no economic evidence that can lead one to conclude that the US needs to reduce its budget deficit during a time of widespread unemployment.

It is a morality play, plain and simple.

It is, as Ryan says, a debate about "different ideas about government". It is about "should", not "can". The government CAN provide a safety net that feeds our poor, that houses our homeless, that cares for our sick, that hires our jobless, that supports our aged in dignity. There is no question of affordability -- sovereign government can always afford to "credit bank accounts" (as Chairman Bernanke puts it) using keystrokes. The question is SHOULD the government do so?

On one side, we have the modern Hooverites, including Ryan. Nay, they say, government should not help its citizens. Quoting Grover Cleveland, Hoover used remarkably precise Ryanesque words: "Though the people support the government, the government should not support the people." President Reagan modernized that with the argument that "government IS the problem". (And just to prove that Democrats can be Hooverish, too, President Clinton's slogan was "The era of big government is over".) Ryan puts it this way: "Let's choose to put proper limits on our government and unleash the initiative and imagination of the world's most exceptional people."

It is not clear who those "exceptional" people are, but the past two decades have demonstrated beyond a reasonable doubt that as government withdraws, it is Wall Street that is unleashed -- the "initiative and the imagination" of the Bernie Madoffs, Jamie Dimons, John Macks, Joe Cassanos, Dick Fulds, Bob Rubins, Angelo Mozilos, and Lloyd Blankfeins run loose. And when they crash the economy, causing unemployment and poverty to explode, according to Ryan's moral compass government should do nothing to help its citizens.

On the other side, we've got the modern New Dealers, who know that unbridled capitalism inevitably devolves to thievery. You need government to protect its citizens from the excesses. To be sure, New Dealers recognize the benefits of Schumpeterian entrepreneurial spirit, but they share the skepticism of Adam Smith who said that our captains of industry rarely meet except to plot against the best interests of our nation's workers and consumers. And they know that each time we experimented with laissez faire, it led to economic depression, brought on by the robber barons and their Wall Street financiers in the late 19th century, the Wall Street investment bankers of the 1920s, and the Wall Street investment bankers (yet again!) in the 2000s. (Does anyone see a pattern?)

Sandwiched between the Hoovers and the New Dealers, we've got the Clinton-Obama New Democrats who want to please Wall Street in order to keep the campaign dollars flowing, while also preserving some modicum of a safety net. Thus, they adopt the schizophrenic deficit dove position: deficits are OK now, to clean up the mess caused by Wall Street, but we've got to reign-in "entitlements" to balance the budget once the crisis is past. Oh, and let's not mess with Wall Street, which has surely learned its lesson this time around. These New Dems are unwitting and unscripted characters in a morality play they do not understand, confusing economics for morals. Hence, they hold their noses and side with the New Dealers for the current deficit debauchery, but to atone for their sins go with the Hoover deficit hawks for balanced budgets in the sweet hereafter.

Here's the problem for the Moral Right and the Schizoid Center. In poll after poll, the American people consistently reject spending cuts for any program other than "foreign aid". Indeed, they want more federal government spending for education, veteran's benefits, (national) healthcare, and Medicare -- areas our morality warriors plan to cut. According to the recent PEW survey, 45% of Americans are willing to cut global poverty assistance; no other category of federal government spending comes close to achieving a majority in favor of cuts, as the following table demonstrates. (Find the full report here.)

Note that aside from global poverty assistance, only military defense and unemployment assistance find slightly more support for cuts than for spending increases; in all other areas, Americans favor more spending. Even Medicare -- a favored target of deficit hawks -- finds nearly three times more Americans favoring spending increases than the tiny minority willing to cut it. And Social Security remains the most popular government program ever -- no matter how often the deficit hawks tell Americans that no progress can be made on deficit reduction without gutting Social Security.

Disingenuously, Representative Judy Biggert claimed that Republicans "have a mandate from the American people to cut spending". They have nothing of the sort. The mandate is loud and clear: Americans want investment in all those areas that will improve the quality of life now and in the future.

Nor do Americans want higher taxes -- except on the super rich. But since the super rich are the natural constituency for the Moral Minority and the New Dems, that idea has no chance.

In short, the problem is that if democracy ever had its way in America, the government would be substantially BIGGER, not smaller, and MORE generous, not less. Americans decisively reject modern Hooverism, in spite of the anti-government campaign run out of Washington over the past thirty years.

I hope that Rep. Paul Ryan's admission that deficit hysteria is really about morality, not economics, gets wide coverage. The American people need to know that the morality campaign is well-financed by hedge fund manager Pete Peterson's billions. He and Ryan want to push their Moral Minority views on the Moral Majority.

But the Moral Majority of this country wants more education, not less. Americans want more publicly funded healthcare, not less. They want to help the homeless get off the streets. They want to help grandma and grandpa live a decent life in retirement. They support nutrition programs for mothers and infants. They want to rein in Wall Street and to jail the crooks. And they want government to play its appropriate role in all these matters.

And most of all, they want to leave the world a better place for the generations of Americans to come. As such, they do not, as Ryan put it, "choose to relegate America to another chapter in the history of declining nations." They want no part of the "dog eat dog", "every man for himself", Hobbesian vision hawked by the Morality Minority.

They reject Ryan's "case for limited government" and instead want a government that serves its people.

Let us start with honesty about budget deficits and government debt. There is no honest economic argument against running budget deficits when the economy is below full employment. While we can debate about which programs government ought to fund, and at what level, and about who ought to pay taxes, and how much, there is no legitimate concern about the size of the resulting budget deficit or growth of government debt.

Surely, in a democracy these spending and taxing issues should be decided by the voters, but in a process that is free of all the fear mongering about deficits. The Moral Minority wishes to conceal the truth behind the deficit hysteria because it knows that the majority rejects the minority's position as immoral.

It is not moral to cut nutrition programs for pregnant women and infants, and to eliminate funding of family planning. It is not moral to cut Social Security benefits while handing payroll taxes over to Pete Peterson to supply money to his hedge fund activities. It is not moral to cut the IRS enforcement budget to let Wall Street's tax cheats protect their fortunes. And it is not moral to withhold funding from Wall Street's regulators, such as the SEC (which the GOP plans to cut).

Yet, all of these are components of the Moral Minority's unpalatable platform. No wonder Ryan wants to hide behind his "moral imperative" to cut government -- to keep the debate in the religious arena of morality and away from the light that economics might shine upon it.

L. Randall Wray is Professor of Economics at the University of Missouri-Kansas City.

The Center for American Progress's Matt Miller has argued that liberals can learn a valuable lesson from NY Governor Andrew Cuomo's proposed budget. With his state facing a fiscal crisis, the Governor has proposed to cap growth of state spending on the Medicaid program. Miller has argued that we should follow his example and apply a similar cap to Social Security spending.

Briefly, New York's Medicaid spending was slated to grow by 13%, much faster than the overall inflation rate. Governor Cuomo has proposed to ignore funding formulas and to limit growth to 6%. Miller wants liberals to follow that example by changing Social Security's formula used to adjust benefits.

Miller rightly notices that Social Security expenditures are also projected to grow faster than inflation. Of course, some of that is due to our aging society, with more retirees to support. But funding formulas for Social Security also contribute to growth of individual benefits beyond cost of living adjustments. In other words, Social Security expenditures in real terms (after inflation) increase faster than growth of the retired population, meaning that the benefits received in the future by a retiree will be higher in real terms than they are today.

Here's why. In the 1970s it was recognized that if real living standards rise over time (due to growing productivity of workers), then Social Security retirement benefits would fall behind even if they are adjusted for inflation. Suppose you retired today at age 65 and were fortunate enough to live another 25 years to the ripe old age of 90. Let us say you retire at the typical benefit of $18,000 paid to one who has earned a medium wage pre-retirement. If that benefit is adjusted every year to account for inflation, when you die in 2036 you will still be able to buy the same consumer basket in your last year of life (assuming the COLA adjustments accurately reflect inflation -- something that is not really true). But over that 25-year period you will watch as the average American living standard rises relative to your own. You will become relatively impoverished.

Over a period that long, it is likely that living standards will have increased substantially; over the course of US history they have typically doubled each generation. You will have fallen far behind in relative terms -- from a not-so-comfortable living standard ($18,000 is by no means extravagant today) to a living standard that is half as good in relative terms.

For comparison purposes, based on current formulas, your Social Security retirement is projected to grow in real terms from that $18,000 now to $24,000 in 2030 and to $29,000 in 2050 (should you be so lucky to live to the age of 104!). Your living standard will grow by 60% as it keeps pace with the growth of American workers' living standards. In relative terms, you do not fall behind. If everyone else is driving flying saucers to Venetian vacations, you'll be able to do the same.

There are of course two objections. First, we do not know how much living standards will rise. It will depend on growth of labor productivity. But by linking growth of Social Security benefits to real wage growth we are ensuring that no matter how much productivity grows (whether it is zero or 400 percent), seniors will get their share.

Second, one could argue that in absolute terms, seniors are no worse off if we limit benefit growth to cover inflation. They'll probably still live better in America than they would in India, after all.

But one thing we do know is that well-being depends more on relative comparisons than on absolute terms. Relative poverty is more detrimental to one's physical, psychological, and emotional health than is absolute poverty. At first that might sound counterintuitive, but researchers from many disciplines have consistently found this to be true. It is relative poverty that isolates an individual, that reduces her ability to participate fully in society. So while it is commonplace to note that America's poor are rich by Indian standards, that comparison is irrelevant.

Miller's justification for elimination of the real living standard adjustment is based on two fallacies.

First, he argues that financing growth of Social Security benefits will "crowd out" all the other liberal priorities. The federal government simply will not be able to "afford" the costs of "guaranteeing great teachers for poor children, universal preschool, repairs for America's crumbling roads and sewer" if we let living standards of seniors rise.

Second, he refers to growing numbers of retired baby boomers as the cause of the problem. It is a little publicized fact that when the intergenerational warriors trot out their "unfunded entitlements" that supposedly total tens of trillions of dollars, the shortfall is entirely due to the projected deficits in the long distant future after all baby boomers are dead and buried. The projected date of Armageddon, when Social Security first starts to run deficits (that is, when its total revenues fall short of its benefit payments) changes from year-to-year as assumptions change based on recent economic performance. But typically that date is sometime in the 2040s.

Think about it. The babyboomers will be closing in on the century mark by then. Yes, a few of them might make it. But most of us partied way too hard in the 1960s and 1970s. Heck, we were surprised to make it to the 1980s.

I do not have the space to go through all the reasons why the very long-term (75 years and beyond) projections of Social Security's finances show growing budget deficits -- but it mostly comes down to implausibly pessimistic and inconsistent assumptions about economic variables. In any case, it turns out that the projected financial shortfall amounts to about 2% of GDP per year after 2040 or so. In other words, if we find a way to shift 2% more of GDP annually toward Social Security's funding over the next 30 years, the "looming financial crisis" disappears. By the way, we achieved a greater shift than that between 1960 and the 1990s. Only an ideologue could trump that up to a crisis.

But forget the finances. What really matters is growth of our nation's ability to take care of the young, the workers, and the aged. Will we be able to produce enough goods and services to provide a rising living standard to all (supplemented by imports -- if the rest of the world continues to prefer to "consume" green paper money over their own output, a topic for another day)? On all plausible projections the answer is a resounding "yes". Indeed, even the pessimistic projections made by the Social Security Trustees shows rising living standards for all even as we age as a society.

That makes sense. The average worker in 1965 supported more dependents (young plus old) than workers are ever projected to support again. Why is that? Elementary: the parents of baby boomers supported 3.7 kids; the flip side of an aging society is that workers today and into the future are supporting more old people but fewer kids. It's a tradeoff. We may not like it, but the alternatives are unpleasant: euthanasia for the elderly or very much higher birthrates. Far better to accept the aging society and to continue to ramp up productivity so that we can provide for them.

Indeed, it is precisely that productivity growth that drives the growth of real benefits that Miller wants to cut! If we don't get rising productivity, we don't get rising real benefits. Miller is focused on something that is not an issue, and has created a "solution" for something that is not a problem.

L. Randall Wray is Professor of Economics at the University of Missouri-Kansas City.

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Myths and misconceptions about our best-loved program only add fuel to the critics' fire.

Myths and misconceptions about our best-loved program only add fuel to the critics' fire.

It is clear from the comments on our last piece that we might have raised more questions than we answered. Above all, we want to make clear that when we discuss the funding aspects of the Social Security program, we are doing so in a way that is designed to safeguard it, not eliminate it. We believe that fictions are not necessary, because the truth will protect the program better than distortions, however well-intended. Enemies have lied enough; supporters do not need to battle fictions with more fictions. Here we will deal with a dozen issues surrounding the proposed payroll tax holiday, and illustrate why we do not believe that the holiday is a danger to the program -- as long as we understand the facts.

1. Social Security Has Deep Support. Social Security is consistently counted as America's most popular program. It lifts millions of seniors out of poverty. It provides benefits to widows, dependents and persons with disabilities. It has never missed a payment due. It is a federal government program, and as such has the full faith and credit of our government standing behind it. There is absolutely no reason to believe that it would ever default on its commitments. Its promises are as secure as any promises made anywhere in the world. One of the things that makes it so popular, and hence safe from political interference, is that it is essentially a universal program -- Congress determines eligibility requirements. It has no means tests, so unlike "welfare" programs it is available for poor and rich alike. So it commands political legitimacy in a way that welfare programs do not.

2. Social Security is a Generational Promise. In real terms, Social Security is an assurance program, maintained by a promise by Americans of working age to provide material support for seniors and other beneficiaries (those widows, dependents, and people with disabilities). It is an assurance that is renewed every generation: those of working age produce the goods and services needed by Americans of all ages, secure in the knowledge that when they become aged or infirm, the next generation will work hard to support them.

3. There is No Viable Alternative. What would be the alternative to this social assurance program? Previous to the creation of Social Security, most elderly people lived in (or near) poverty, relying largely on handouts coming from their own children or, in many cases, from charities. Few Americans had adequately provided for their own retirement. All studies today demonstrate that the average American still has not adequately prepared for retirement. For most Americans, the Social Security "leg" of the retirement stool is absolutely essential for a dignified retirement. There is no reason to believe things will ever be different. There is no alternative to public support for retirement. If we also add in widows, dependents, and people with disabilities (who now account for a quarter of all beneficiaries of Social Security) it becomes even more obvious that Social Security is necessary and is here to stay.

4. The Payroll Tax is Unpopular. In spite of the defense by well-intentioned, albeit misguided, liberals, no one really loves the payroll tax. It is the most burdensome federal tax for 70% of all Americans. It adds to the cost of employing American workers -- making it hard to compete in a global economy in which many of our competitors have no equivalent business cost. In most nations, a public pension for retirees, as well as social protection for dependent youths and people with disabilities, is not a cost imposed on business. Rather, it is a cost born by society as a whole. In America we impose a cost on employment -- both employee and employer -- that is not typically born by our competitors. Just as in the case of imposing health care costs on employers, the US almost uniquely puts barriers in the way of employment. Social Security alone adds 12.4% (half each on employer and employee) to employment costs.

Further, the tax is poorly designed because it is regressive, with much lower tax rates on high income earners. It also taxes only employment income. This is extremely problematic in a nation in which the share of wages in national income has been declining on trend and is projected to continue to decline in coming decades. While we do not endorse such projections, we wish to point out that these have a lot to do with the projections of future financial "shortfalls". In addition, as income becomes more unequally distributed, more employment income at the top becomes exempt from the tax -- another reason for projected shortfalls. Again, we do not endorse the projection, but it provides fuel to the fire of neocons who point to projected shortfalls in their argument that the program is financially unsustainable.

Our point is that a payroll tax cut reduces employment costs, will restore 'spending power' and, by helping households to make their mortgage payments, will help to fix banks from the bottom up. Maximizing employment and output in each period is a necessary condition for long-term growth. A payroll tax reduction helps to mitigate the impact of rising unemployment. So even on the conventional accounting grounds that today's Social Security Trust Fund will have "shortfall" (to reiterate, a position which we do not endorse), full employment provides greater tax revenue to the government, which will shut down these discussions about Social Security's "affordability".

5. Tying Social Security to the Payroll Tax is Problematic. Even if we strictly stick to conventional understanding of government finance, it makes little sense to tie the program's fortunes to the payroll tax for the reasons enumerated above. The tax base has been falling. The tax is regressive. The tax helps to make America uncompetitive. More importantly, the tax is almost unique among federal taxes -- it is "dedicated" to a single program. That allows both "money's worth" (comparing taxes paid to individual benefits received) calculations as well as calculations of "Armageddon day" (when revenues fall short of benefit payments). It also has led to completely unnecessary tax hikes over the years, from a tax of about 2% of wages on the parents of baby-boomers to the current 6.2%. These current tax rates have nothing to do with current benefit payments -- Greenspan pushed them up far beyond what was necessary on the argument that we needed "advanced funding" for benefits that would be paid 50 or 75 years into the future.

By contrast, there is no dedicated military tax. Imagine tax policy that would try to increase taxes today on the argument that we will need to increase military spending in 2075. It would be rejected as nonsense. In fact, no one wastes time trying to calculate the defense spending "shortfall" through the next 75 years, let alone "infinite horizon" shortfalls (as is done by inter-generational warriors in the case of Social Security). Too silly to imagine. Without a "dedicated" payroll tax, such calculations would never be done because they could not be done. A "hypothecated tax" supposedly designed to safeguard Social Security's long-term viability, then, actually provides the political means to destroy it.

6. Ignoring "Financing", There is no Social Security Crisis. As we explained in our first piece, aging raises the real "burden" in the sense that eventually we will have only two workers per beneficiary versus three today. But all reasonable projections of rising worker productivity easily takes care of that. If we stick to "real" arguments, Social Security proponents can defeat neocon critics hands-down. The burden rises very slowly, and by less than it has risen over the past half century -- we have already dealt with a rising number of seniors as great as what will occur in the future.

In truth, we have already completed most of the transition to an aged society. And it ain't that bad. Yes, we need more old folks' homes; but we need fewer day care centers. We need more hip replacements but we need fewer neonatal units. It is almost a wash -- that transition from baby-boomer young to baby-boomer old. And they'll all soon enough be gone, anyway. In truth, the baby-boomers were a blip on the historical radar screen and we are almost done with them. Yes, they were a burden -- from birth to death -- but they gave us one heck of a lot of excitement, from war protests to sexual revolutions, and from drug experimentation to the best music the country ever produced.

7. Sustainability Calculations Are Distorted. Only in financial terms can the program look unsustainable -- but that is entirely due to the myth that the payroll tax must pay for the program. The shortfall is due to several factors, most of which are based on the assumption that recent trends will continue. As discussed above, it is partially due to projections that the distribution of income will continue to shift away from wages and toward rentier income and high income earners. It is also due to projections of low wage growth and to other projections about "real" variables: low immigration of workers to the US, low economic and productivity growth, low birthrates, falling retirement ages, and low labor force participation rates. Most of these are arguable, and some are policy variables (if desired, there is a nearly infinite supply of potential immigrants).

But the bigger point is the one we have made above: these sustainability calculations rely on projections of faster growth of benefit payments relative to the growth of payroll tax revenue. If there were no dedicated tax, there could be no "financial" calculation of sustainability. Instead, we would have to focus on the much more relevant "real" variables: will we have enough workers of sufficient productivity to produce all the goods and services we will need to support elders, dependents, people with disabilities, and workers? The answer is a resounding "Yes". There is no controversy about that, even taking the pessimistic assumptions used by program critics. The "financing" diverts us from the real issue.

8. The Holiday is Good for the Economy. Eliminating the payroll tax ends the irrelevant "money's worth" and "sustainability" calculations. It also relaxes the fiscal stance by an amount that is probably sufficient to remove the fiscal drag that prevents the economy from operating at full employment. The "holiday" is a move in the right direction with regard to loosening the fiscal stance and tax relief is well-targeted to workers and firms. We can begin with the 2 percentage point reduction and move forward to greater reductions. It is possible that our calculations are wrong. If so, it will be necessary to increase taxes or reduce spending when -- and if -- our economy finally recovers. When that becomes necessary, there are better taxes than a payroll tax that punishes employers and especially lower and middle class workers.

9. Payroll Taxes Do Not "Pay for" Social Security. Let us first look at this from a conventional viewpoint of government finance. Benefit payments are made by Treasury, just like any other federal government spending. Payroll taxes are paid to Treasury, just like any other federal taxes. If total spending, including Social Security, exceeds total tax revenue, including payroll taxes, the government records a budget deficit. It does not matter whether one part of the budget -- say Social Security -- receives dedicated taxes greater than spending. We can just as easily imagine that fuel taxes "pay for" transportation, and that income taxes "pay for" military adventures. If Social Security runs a surplus but the rest of the budget runs an equal deficit, the government has a balanced budget. It can say that the rest of the budget "owes" Social Security -- but that is just internal record keeping. Later, if the rest of the budget continues to run deficits and then Social Security also runs a deficit, the sum of those two equals the budget deficit -- an external deficit. The internal records that show Social Security has run years' worth of surpluses do not change that fact at all. From the perspective of the budget as a whole, this internal accounting makes no more sense than when a household allocates the husband's income to the house payment and the wife's income to the auto loan with careful record keeping to track the husband's debt to the wife when he comes up short. If total income is less than spending, there is an external budget deficit and the wife cannot collect from the husband on all the internal debts he may owe her from previous years.

But in reality, the government is not like a household and we cannot use conventional views about government finance. While we treat tax revenues as "income," it is not the same as a household's income and does not really finance government spending in the way that a household's income finances its spending. The government actually receives back its own IOUs when taxes are paid; it issues its own IOUs when it spends. Deficits mean it issues more IOUs than it receives back. It cannot run out of its own IOUs. This is not a policy proposal, but rather a description of government spending.

We do not imply that the government can never issue "too many" IOUs. The government can spend too much, causing inflation and, possibly, causing currency depreciation. But when the government promises to make Social Security benefit payments, it is promising to credit bank accounts with its own IOUs. It cannot run out; it will never reach a point at which it cannot fulfill its promise. "Finance" is not constrained in this case. This is not a controversial point; it is accepted by all mainstream economists from Paul Samuelson (who wrote the textbooks most students used) and Milton Friedman to Ben Bernanke. There are many other issues associated with government spending -- it can be of the wrong type, it can be so large that it causes inflation, it can reward friends and punish enemies, and so on. But it cannot be financially constrained.

10. Political Reality Check. Our support for a tax holiday has been labeled "politically naïve." You want political reality? Retaining the fiction that payroll taxes "pay for" Social Security only gives ammunition to the enemies for the reasons we discussed above -- it makes it possible to calculate the program's shortfall. Amazingly, Social Security's "friends" (like President Clinton and Candidate Gore) accept those calculations! And just what do many "progressives" advocate to resolve the program's projected financial shortfall? Raising the cap so that taxes can be increased on higher income people. That is supposed to be politically popular -- a way to influence friends and convert enemies? Social Security is already a bad "money's worth" deal for high income people, who would much rather pull out and invest their savings in Wall Street.

Others want to means test the program -- again, targeting the high income to reduce their benefits. To generate more support among high income employees and the self-employed? Talk about political naiveté. In case no one has been noticing over the past half century, high income people have influence in Washington and do not need Social Security. They would love to pull out or gut the program.

By tying Social Security's fate to the payroll tax, progressives commit themselves to battling over financial "sustainability" and to difficult political choices that come down to raising payroll taxes or cutting benefits.

11. Defending the Payroll Tax Plays Into the Hands of Social Security's Foes. There is nothing more ironic and destructive than "progressives" refusing to give a payroll tax holiday to beleaguered workers. It plays right into neocons' hands. Keeping payroll taxes far higher than necessary to match benefit payments was precisely Greenspan's 1983 scheme to reduce popularity for the program. To some degree, it has been successful.

Imagine a truly progressive strategy that promised to eliminate the payroll tax to help workers and their employers. How much goodwill would that produce for the progressive cause? And how much fiscal stimulus would that add?

We would then move the focus to real issues: preparing our economy for a growing elderly population and for fewer workers per beneficiary. Education and training could increase future productivity. Policies that maintain high employment and minimize unemployment (both officially measured unemployment, as well as those counted as out of the labor force) are critical to maintaining a higher worker-to-retiree ratio. Policies can also encourage seniors of today and tomorrow to continue to participate in the labor force. The private sector will play a role in all of this, but there is also an important role to be played by the government.

The broader point is that any reform that seeks to address growth in the context of Social Security's "sustainability" ought to be made with a focus on increasing the economy's capacity to produce real goods and services today and in the future, rather than on ensuring positive actuarial balances between payroll tax receipts and benefit payments through eternity. Unlike the case with individuals, social policy can provision for the future in real terms -- by increasing productive capacity in the intervening years. For example, policies that might encourage long-lived public and private infrastructure investment could ease the future burden of providing for growing numbers of retirees by putting into place the infrastructure that will be needed in an aging society: nursing homes and other long-term care facilities, independent living communities, aged-friendly public transportation systems, and senior citizen centers.

12. Americans Want a Better Life for Future Generations. Throughout our history, Americans have always been willing to sacrifice to make our nation stronger over the long haul. That's America's promise: to give our children and grandchildren a better life. And if we succumb to the maniacal protests of the deficit reduction fetishists and cut back net public spending now and drive millions more workers out of jobs, then we will be guilty of crimes against our children and grandchildren. That's the real "inter-generational theft" that ought to concern us, not a reduction in the payroll tax.

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The payroll tax holiday can help move us away from myths about the Trust Fund.

The payroll tax holiday can help move us away from myths about the Trust Fund.

One of the highlights of the president's compromise on the tax bill is a temporary payroll tax "holiday" -- something we have long advocated for along with others such as James K. Galbraith and Warren Mosler. The proposed deal would cut the tax by two percentage points from the current 6.2% applied on employment income up to $106,800. The beauty is that it can take effect immediately, raising weekly take-home pay and totaling about $112 billion in fiscal stimulus annually. Since the vast majority of Americans pay more in payroll taxes than in federal income taxes, it provides broad-based tax relief (unlike the original Bush tax cuts that were skewed to high income earners in part because they pay most of the federal income tax). The payroll tax itself is regressive because high income earners escape FICA taxes on most of their employment income, so reducing the federal government's reliance on it should be celebrated. In other words, this holiday is a progressive's dream come true.

Instead of cheers, however, the liberal left is worried about this plan. For example, Heidi Hartmann argues that it puts Social Security at risk because it will be difficult to end the "holiday" by restoring the two percentage points later. She also offers an alternative that would achieve essentially the same tax relief through tax rebate checks, thereby leaving the payroll tax alone. This is offered as a lower risk alternative because it is easier to stop the rebates than to restore payroll taxes, which will be seen as a tax hike. But her defense of the payroll tax is fundamentally misguided.

Indeed, it seems along the lines of presidential candidate Al Gore's promise in 2000 to "lock up" the budget surplus in something akin to a Social Security Trust Fund safe, to be tapped later when baby boomers retire. In retrospect, Gore's idea of a government lock box storing up savings turned out to be as much of a myth as the idea that a Social Security Trust Fund could provide advance funding for a retiring baby boom bulge. What will matter in the future is our capacity to produce real goods and services. Accumulating paper money or electronic charges on computer tapes does not in any way help to take care of the elderly. And when the time comes, government can always make the monetary payments as they come due.

Let us step back from the fray and try to understand just what Social Security is. In truth, it is an inter-generational assurance plan. Working generations agree to take care of retirees, dependents, survivors, and persons with disabilities. Currently, spouses, children, or parents of eligible workers make up more than a quarter of beneficiaries on the Old-age, Survivors and Disability Insurance program (OASDI). A large proportion will always be people without "normal" work histories who could not have made sufficient contributions to entitle them to a decent pension. Still, as a society we have decided they should receive benefits. (For more, see "Social Security: Truth or Useful Fictions?", "Does Social Security Need Saving?" and "The Neocon Attack on Social Security.")

Most discussions of the program get hung up on the relationship between payroll tax receipts and Social Security benefits because those receipts are said to be necessary to "pay for" the benefits. This then leads to "money's worth" calculations (the "return" an individual "receives" on his payroll tax "investment" in Social Security -- as if the program were like an IRA) as well as the "day of reckoning" when total payroll tax receipts will fall short of Social Security spending. Inter-generational warriors love to calculate that Social Security is a bad deal for most of today's workers, who would be much better off if they took their taxes and invested them in Wall Street (whoops, maybe not such a great idea right now). And they read each annual report of Social Security's Trustees to find the precise year for Armageddon: when payroll tax revenues are expected to fall short of Social Security benefit payments. Even without the crisis and recession, that would have happened later this decade. Defenders of the program then trot out their own numbers, proclaiming that Social Security is indeed a great deal for a worker who loses a leg in an industrial accident, rendering her unable to ever work again -- a not entirely successful counterclaim for the average worker who prefers not to think about such a scenario.

Defenders also point to the supposed cushion offered by the Trust Fund, which has trillions of safe Treasury bond assets to keep the program solvent. While it is widely claimed that interest receipts and then Trust Fund bond sales will maintain the program for a couple more decades, Social Security's enemies argue that the program faces calamity much sooner because its Trust Funds are a fiction. As we've long argued, the Trust Funds cannot provide external financing for one of the government's own programs, because this is a case of the government "owing itself", an internal accounting procedure.

To understand the current set-up of Social Security, we need to go back to the Greenspan Commission, which tried to change Social Security from "paygo" (tax revenues equal benefits) to "advance funding" (taxes exceed spending) in 1983. Before the crisis, the payroll tax was set about two percentage points higher than necessary for total revenues to equal benefits paid. So the proposed payroll tax holiday essentially returns the program to "paygo". But in truth, tax revenues never "pay for" benefit payments -- either on an individual level or at the level of the program as a whole. This was well understood at the time the program was originated. However, President Roosevelt feared that Social Security would be seen as welfare or, worse, as socialism. So a fiction was maintained: that there would be both an individual link between taxes paid in and retirement benefits paid out (albeit, a loose one), and that at the aggregate level the payroll tax "pays for" benefits. Later, Greenspan's Trust Fund would provide a buffer stock of "money in the bank" for the inevitable date on which a shortfall would occur. These twin beliefs are what James K. Galbraith would call a "convenient fiction" and over time they became a not so innocent "innocent fraud".

Liberals have come to see that payroll tax fiction, as well as Greenspan's Trust Fund fiction, as necessary to maintaining support for Social Security. Perhaps there was a time when this was true. But the fictions have become an albatross around Social Security's neck. They are forcing left-leaning liberals to oppose tax relief for workers, arguing for a tax rate that is set well above what is required to generate revenues equal to benefits in a growing economy (and thus acting as a fiscal drag on an already suffering economy). Worse, they fuel the fire of Social Security's enemies, encouraging calculations of money's worth and Armageddon day. Inter-generational warriors are able to estimate with some precision the program's budgetary shortfall at something like $10 trillion. Since payroll taxes are already so high as to burden most Americans more than the income tax, virtually no one advocates tax increases to close the shortfall. Hence the debate centers on when, and by how much, benefits must be cut. President Obama has been sucked into this debate, adopting the neocon view that the program is unsustainable because there is a coming shortfall.

Liberals are left proclaiming they will never give up the payroll tax because that would be the first step on the road to dismantling the program. What if there were no payroll tax? What if Social Security were just another program, like defense or corporate welfare or farm subsidies? With no dedicated source of tax revenues, there would be no way to calculate "money's worth" (infinite, just like corporate welfare!) or "unfunded entitlements" (zero, just like farm subsidies!). Government would continue to pay benefits in the same way it pays benefits today: by crediting bank accounts. Indeed, it is the only way a sovereign government ever makes payments. And it taxes by debiting bank accounts. Tax revenues do not go anywhere; they cannot be locked up in boxes and they do not fund spending. They are simply a "negative credit" -- a deduction. If total payments exceed total taxes, the government books a deficit that is equal to the net credits to bank accounts. Proclamations by liberals that they will give up the payroll tax only when their dead fingers are pried from it does nothing to help government's finances. Hartmann says that most Americans report that they do not mind the current payroll tax rate. Ask them if they'd like to see it fall to zero, and ask firms if they'd like to see the cost of hiring workers fall by eliminating it.

In reality, the best way to "save" Social Security would be to adopt policy prescriptions that would make sense even if our society were not aging. That is, adopt those policies that would increase our capacity to produce in the future: 1) more human capital: more years of schooling, fewer dropouts, higher quality schooling, and enhanced apprenticeship and training programs; 2) more public investment: new and improved public infrastructure, better maintenance of existing infrastructure, and reduction of adverse environmental impacts; and 3) more private investment: new and improved private production facilities to enhance growth. The last item will almost certainly require maintenance of high aggregate demand today and over the near future.

Hence, true reform must be geared toward higher employment or increased productivity, which comes down to encouraging more capital formation. Further, the types of investments that can be made today to reduce burdens in the distant future are in human capital and public infrastructure. That is to say, the investments must be undertaken primarily by the government. Yet most self-styled reformers seek to reduce the role of government and increase reliance on the market, which by its very nature is focused on the here and now, not on infinite horizons.
Let us also be clear: the Social Security retirement benefit is not welfare. Retirees have earned their benefits. Not by paying taxes, but rather by working and contributing to the production of the goods and services needed by past and present generations of retirees. Those retiring today and tomorrow should be proud of the contributions they made. And those contributions take the form of the American workers' accumulated annual produce. Many of their contributions are still in evidence and are still being enjoyed: our housing, our schools, our bridges, our educated population, our arts and literature, and our justice system.

The fact that retirees paid payroll taxes is the least of their contribution. Note that we do agree that taxes are one of the two unpleasant inevitabilities (death, unfortunately, is the other). But their purpose is not to raise revenue to fund a government program. From inception, taxes create a demand for our sovereign currency. Working hard for money gives money its value; retirees have worked hard over their careers, giving value to the money that we award them in their retirement. They pass the burden of work on to the next generation of workers, who keep money strong and provide the goods and services the retired generation needs. Social Security is really a social compact among generations. This is something the inter-generational warriors wish to deny. The prudent course of action is to leave Social Security alone until changes have to be made. If it turns out that more of society's output has to be shifted to retirees in 2035, then the most effective and most direct method of achieving that shift of distribution will be to use the tax system in the year 2035 to do so. Cutting benefits over the next few years simply lowers living standards prematurely without in any way reducing burdens on future workers.

So let us have a permanent payroll tax holiday. But meanwhile we need to strengthen our social compact, not by legislating future benefit cuts (which reduce the willingness of today's workers to join the compact), but rather by legislating more generous retirements.

On the eve of President Obama's arrival to the G20 talks in South Korea, a growing chorus of voices is questioning the direction of U.S. monetary policy. Germany's finance minister, Wolfgang Schaeuble, went so far as to scold Chairman Bernanke, saying "With all due respect, U.S. policy is clueless." Some critics (with justification) have argued that America is guilty of the "currency manipulation" policy for which it castigates China. Others have argued that US policies are opening the door to a complete revision of the international monetary system based on the dollar. World Bank president Robert Zoellick appeared to even suggest a return to the gold standard when he talked of "employing gold as an international reference point of market expectations about inflation, deflation and future currency values."

I already argued that QE2 is more of a slogan than a policy, and will not repeat those criticisms here. Rather, I will deal with the two most important issues and misunderstandings surrounding quantitative easing. The first concerns the consequences of injecting another $600 billion of excess reserves into the banking system. The second is associated with the Fed's attempts to lower long-term interest rates through purchasing treasuries. Both of these issues are in turn connected to the belief that QE2 will devalue the dollar and threaten its status as the international reserve currency. That, however, is a topic for another column.

All developed countries' central banks now operate with an overnight interest rate target (the fed funds rate in the US). To hit this rate, they must supply reserves more or less on demand. We can think of the supply of reserves as "horizontal", that is, as an infinitely elastic supply at the target interest rate. The simplest way to operate such a system is to offer "overdraft" facilities at the central bank, lending on demand at the target rate (this is done in Canada). Knowing that they can obtain reserves any time they want, banks would never hold substantial excess reserves, since they could borrow them as needed.

The Fed has never explicitly operated this way, preferring to supply most reserves through its open market operations (purchasing treasuries) while imposing "frown" costs on banks that come to the discount window. Most of the time, this does not really matter. However, when the financial tsunami hit, the fed funds market froze up as banks refused to lend to one another, even on the basis of good collateral. There was a general run to liquidity, and no bank felt it could get enough reserves to see it through the crisis. The Fed played around with an alphabet soup of auction facilities rather than simply announcing that it would supply reserves on an unlimited basis to all comers. That cost the economy dearly by dragging out the liquidity crisis. Fortunately, the Fed finally stumbled upon the obvious: supplying reserves in sufficient quantity. The liquidity phase of the crisis passed, and the Fed got the short-term interest rates down to its near-zero target.

So here is where Bernanke's pet, quantitative easing, came in. Conventional wisdom is that the once the central bank takes the short-term rate to zero, it has shot its wad. Nayeth, sayeth Bernanke -- the Fed can continue by flooding banks with excess reserves, which they do not want to hold. Some commentators have said that banks would eventually begin to lend out the excess reserves, seeking a higher interest rate than the Fed pays them. One hopes Bernanke never made that mistake -- banks do not lend reserves (except to one another), since they exist only as entries on the Fed's balance sheet. Only an institution with a "checking account" at the Fed can hold reserves, so there is no way a bank can lend these to households or firms (which do not have accounts at the Fed). So Bernanke presumably understood that if for some reason holding excess reserves caused banks to want to increase lending, this would simply shift the reserves around the banking system while leaving the outstanding quantity unchanged. But that means that offering Canadian-like overdraft facilities, promising banks they can have reserves anytime they want them, would have had the same impact as quantitative easing. Rather than actually holding excess reserves, the banks would have been just as happy knowing that they were safely "locked up" at the Fed and available anytime they were needed. In other words, pumping about $1.5 trillion into the banks would be no different than telling them the Fed would supply any amount at any time.

In sum, adding excess reserves to bank portfolios will not, by itself, do anything if the overnight interest rate has already been driven down to its near-zero target. QE2 proposes to add another $600 billion of excess reserves -- but whether banks have $1 trillion or $10 trillion in excess reserves will have no impact.

So why would QE have any impact at all? Because to get those excess reserves into the banks, the Fed buys something from them. What did the Fed buy? Good, safe (mostly short-term) treasuries, and bad, toxic waste: mortgage backed securities. Now, treasuries are effectively reserves that pay a higher interest rate; they are like a saving account at the Fed, rather than a checking account. So when the Fed buys treasuries from a bank, it debits the bank's saving account and credits its checking account. This will have no appreciable impact on the bank's behavior and thus will have no discernible economic effect.

But if the Fed buys trashy assets, and at a nice price, the banks are able to shift junk they don't want off their balance sheets and onto the Fed's. And if the Fed were to do that in sufficient volume, it could turn insolvent banks into solvent ones. In truth, the Fed did buy a lot of junk, but banks were left with trillions of dollars of toxic waste assets -- probably much worse than the trash they sold to the Fed -- so they are still massively insolvent. Thus, while QE1 was useful, it did not come close to resolving the insolvency problem. It bought time for some of the trashiest banks, which they devoted to ramping up their dangerous and largely fraudulent activities, digging the hole ever deeper -- but that, too, is a story for another day.

With QE2, the Fed proposes to buy longer-term treasuries. Since these are not toxic, it will not help the banks. It is like transferring funds from CDs they hold at the Fed to their checking accounts, thereby reducing their interest earnings. I suppose the idea is that the Fed is going to reduce bank income, impoverishing banks to the point that they will finally throw caution to the wind and begin to make loans to struggling firms and households. It is simultaneously a strange view of banking and also a scary remedy to a financial crisis that was created by excessive bank lending to those who could not afford the loans. It's sort of like sending a covey of nymphomaniacs to the hospital bed of a nonagenarian suffering from myocardial infarction initiated by an age-inappropriate tryst.

The only plausible scenario in which this can prove useful is that QE2 pushes up prices of long maturity treasuries, lowering their yields. This could cause other longer-term interest rates to fall through competitive bidding by banks seeking better returns in alternative assets. Now, mortgage rates are already at historic lows, and what is needed to spur real estate markets is not lower interest rates (which will only generate big problems later when rates rise, crushing the holders of legacy mortgages that earn well below 4%) but rather the recovery of real estate markets. Only when it is clear that home prices have reached bottom and turned up will real homebuyers step forward -- that is, buyers other than the vultures making speculative purchases of blocks of homes at pennies on the dollar. So far as business borrowing goes, the problem is the market for firms' output, not excessively high interest rates. So the "bang for the buck" in terms of inducing domestic spending by lowering long-term rates cannot be very large and may not even be positive, since reducing interest rates also reduces the income of savers, which could depress spending.

This brings us back to the international sphere, and the fear that QE2 really means to succeed by "beggaring thy neighbor". Bernanke has talked openly of his desire to raise inflation expectations, and that, in combination with lowering interest rates, could make America a less attractive investment option. If so, the dollar could depreciate, increasing US competitiveness in traded goods and services. This could boost exports.

At the same time, international managed money would be looking for more attractive investments in strong currencies with higher interest rates -- say, the BRICs (Brazil, Russia, India, China) -- fueling appreciation of their currencies. In other words, QE2 would do for the US what Geithner claims Chinese currency policy is doing for China: cheapen our exports. At the same time, many developing nations are also facing destabilizing capital inflows, and worry about a reprise of the Asian crisis of the late 1990s when the flows reversed and wrought havoc on their economies. That is why they are threatening to drop the dollar, reduce capital mobility, and move to some sort of fixed exchange rate based on gold or a new international currency.

I do not have the space to completely address all of these issues, but I will just say that while much confusion surrounds the complaints thrown at the US, there is at least an element of truth in the claim that QE2 puts the burden of adjustment on other nations. The critics are certainly right to argue that so far as domestic policy goes, QE2 does nothing to get the US out of its crisis. In fairness to the Fed, Bernanke has argued that relying solely on monetary policy for stimulus is less than ideal, so one could argue that the Fed is just doing the best it can in the absence of stimulative fiscal policy. That is correct, up to a point -- only fiscal stimulus will get us out of the recession.

But Bernanke is not dealing with the one area for which the Fed does have primary responsibility, and in which a strong Fed policy initiative would do a lot of good: dealing with bankster fraud. Indeed, I believe that even with a huge fiscal stimulus (which is not going to happen) we would not escape another financial collapse and a long and deep economic depression unless the biggest banks are foreclosed. Right now the fraudsters are the biggest barrier to recovery.

At best, QE2 is a diversion from the task at hand.

L. Randall Wray is Professor of Economics at the University of Missouri-Kansas City.